Cost of merger breakup is ‘huge’

Halliburton CEO David Lesar (center) rings the New York Stock Exchange opening bell on Nov. 18, 2014. The previous day, Halliburton and Baker Hughes announced their plan to combine.

Photo: Getty Images file photo

Halliburton Co. is potentially on the hook to pay one of the largest breakup fees in U.S. corporate history now that regulators have sued to block its deal to buy Baker Hughes.

The $3.5 billion breakup fee it agreed to pay if its deal is scuttled would be the largest antitrust fee paid since the Justice Department quashed AT&T’s bid to buy T-Mobile USA in 2011, triggering a $4 billion charge.

And it vastly exceeds the averages.

It represents about 13 percent of the deal’s $26.6 billion present value. By contrast, the average antitrust fee was 5.5 percent and the median was 4.3 percent in an analysis of 104 similar deals over the past decade, according to New York City-based law firm Shearman & Sterling LLP.

“This breakup fee is huge,” said Darren Bush, a law professor at the University of Houston and a former attorney at the Justice Department. “Halliburton was too optimistic about its chances.”

In an industry beset by rounds of layoffs and cutbacks, the breakup fee gives Halliburton an enormous incentive to fight the Justice Department in federal court — a process that could take years. For Baker Hughes, $3.5 billion is enough to more than wipe out the $2 billion loss the company reported in 2015.

How did a deal between two Houston-based oil field services companies come to this? A combination of falling oil prices that damaged the value of the two enterprises, shrewd negotiations on the part of Baker Hughes and perhaps overconfidence on the part of Halliburton’s CEO, Dave Lesar.

The breakup fee is “at the size it is because we are absolutely confident that we’re going to get this thing done,” Lesar told investors as he announced the deal on Nov. 17, 2014.

Ironically, some of the extra scrutiny this deal received may have been triggered by the large breakup fee, said Jeff Floyd, a partner at Houston law firm Vinson & Elkins LLP. A large fee can be a red flag to regulators and investors, signaling that the companies are preparing for an antitrust slog, he said.

“These things are a two-edge sword when you’re negotiating them,” he said. “You’ve sort of highlighted and acknowledged that there’s a real regulatory risk.”

Initially, the negotiated breakup fee was 10.1 percent of the deal’s total value. “Ten percent is large, but not an outlandish number,” Floyd said. But that percentage grew larger as the price of oil, and the stocks of both companies, declined.

Oil fell by as much 65 percent to below $30 per barrel as the proposed deal awaited regulatory approval. When the deal was signed in October 2014, Baker Hughes counted a record high of 1,609 oil rigs operating across the U.S. Later, that count would fall below 500 for the first time since 2010.

Service companies make money by drilling and catering to the needs of producers, and the rapid decline in activity hit both Halliburton and Baker Hughes hard.

In January, 2016, Halliburton said it had cut 22,000 employees since its 2014 peak, or about 25 percent of its workers. Baker Hughes had announced 10,500 layoffs totaling 17 percent of its workforce by early 2015 alone.

Between October 2014 and the end of 2015, share prices at Halliburton fell 35 percent. Baker Hughes shares fell by 14 percent despite the support Halliburton’s potential purchase offered.

With the industry in freefall and the merger on the rocks, the $3.5 billion termination fee began to look more intimidating. By Feb. 1, 2016, the price tag for the merger had fallen from $34.6 billion to $23.7 billion. The termination fee was then equal to 15 percent of the total deal.

Throughout the negotiating process, regulatory filings show that Baker Hughes repeatedly raised concerns about antitrust issues, either out of genuine concern for the deal or in an attempt to boost its negotiating position.

“The draft merger agreement you sent us does not adequately address certainty of closure nor does it provide any compensation to Baker Hughes should a proposed transaction fail,” Craighead wrote in a letter he handed to Lesar.

Baker Hughes requested that Halliburton include what is noted in regulatory filings as a “hell or high water” provision. This provision would require Halliburton to do whatever regulators asked to consummate the deal — even if that meant the liquidation of a huge portion of its business. And if regulators didn’t approve a deal at all, Baker Hughes wanted $5 billion.

Halliburton balked at the provision, but by Nov. 11, after several rounds of offers and counters, Halliburton and Baker Hughes had agreed to the preliminary conditions of the merger. Halliburton would sell up to $7.5 billion in assets to satisfy the Justice Department, and it would pay $3.5 billion if the deal didn’t get antitrust approval.

The agreement cleared the way for a similarly contentious negotiation on the price of the deal. By the time the two executives shook hands on the full deal, Halliburton agreed to pay 1.12 Halliburton shares and $19 in cash for each share of its rival, making the deal among the largest energy mergers ever inked at $34.6 billion.

Antitrust issues, however, were an afterthought when the two CEOs finally came together and dialed into a victory-lap conference call with investors on Nov. 17, 2014. Of the 10 analysts who asked more than a dozen questions on the call, only one raised the issue of an antitrust challenge and a onerous breakup fee.

“We clearly would not have done this deal if we didn’t believe it was achievable from a regulatory standpoint,” Lesar said in response. “We will be starting to meet with the DOJ as of this morning.”

Despite Halliburton’s optimism, the Justice Department’s review soon stalled. By early 2015, the companies had received requests for more information from regulators, an early signal that the merger was under scrutiny.

Deadlines started getting pushed back. In December, Halliburton said it had extended its planned closing date to April 30, 2016, beyond the late 2015 closing date the companies initially had told investors.

By the turn of 2016, European antitrust regulators had launched their own review, and most investors were preparing for the deal to fail or for it to end up in court.

“It’s 50-50 at best,” Bill Herbert, an analyst who follows the companies at Piper Jaffray & Co., said in January.

The Justice Department argues that combining the second- and third-largest players in the oil services business would compromise competition in 23 different markets.

The asset sales that Halliburton proposed to ease these concerns appeared superficial to the regulators.

“I’ve seen a lot of problematic mergers in my time, but I’ve never seen one that poses so many antitrust problems in so many markets,” Bill Baer, assistant attorney general for the Justice Department’s antitrust division, said in a conference call after announcing the suit. “This deal is unfixable.”

Halliburton responded that the Justice Department had made the wrong call in a release shortly after the announcement. The company said the billions in businesses it had offered to sell were more than enough and that a merger would “allow customers to operate more cost effectively.”

Baer argued Halliburton’s overtures don’t come close to bridging the gap it needs to make room for Baker Hughes.

“It’s not a gap; it’s a chasm,” Baer said. “We sat down and evaluated that and concluded this is going nowhere; we’re not going to get anywhere. About the only way to preserve competition is to ask a district court judge to enjoin the deal.”

Halliburton and Baker Hughes both vowed to fight the decision.

If the two companies choose to stick it out, a judge will have the final say on the merger. The litigation could take years, said Orrin Harrison, a partner at Dallas firm Gruber Elrod Johansen Hail Shank LLP . And if the deal isn’t allowed, the breakup fee payment might be litigated or reduced through negotiation.

“These agreements have all kinds of outs in them,” he said.

If not, a $3.5 billion fee won’t sink Halliburton, analysts say. Soon after Lesar shook on the merger, his company raised $7.5 billion though a debt offering to fund the purchase. Halliburton could use those funds to eat the termination fee, and it still would be left in the relatively strong position of having about $6.6 billion in debt, according to a research report by analysts at Raymond James.

In addition, with Baker Hughes off the table, Halliburton would be free to shed the extra employees and logistics assets it had been holding in anticipation of becoming a larger company. The savings could total as much as $350 million per year.

For Baker Hughes, the $3.5 billion fee would provide a short-term boost. The company could use the money to refurbish its equipment, much of which needs service after grueling downturn curbed capital spending, Raymond James said.

But the saga for Baker Hughes may not end with a judge’s ruling.

“Baker Hughes would continue to be an acquisition target,” Raymond James analysts wrote, “even if a deal with a large, direct oil service competitor would be impossible.”